Friday, December 15, 2017
Home and Garden

Don't assume a loan assumption is right for you

With rising interest rates on the horizon, some consumers with homes they plan to sell within the next few years are asking questions about whether they can transfer their low-rate mortgage to a buyer of their house. These are some of the common ones.

What is an assumption?

It is a transfer of responsibility for repaying a mortgage from the seller of the house that secures the mortgage to the purchaser of that house. The purchaser assumes all the obligations under the mortgage, just as if the loan had been made to him or her.

Does my current mortgage contract allow a purchaser to assume my existing low-rate mortgage?

If your mortgage is handled by the Federal Housing Administration or Department of Veteran Affairs, the answer is yes, subject to the agency's approval of the buyer's qualifications. If your mortgage is conventional, the general answer is no — you must get the lender's permission for an assumption, and if they agree, it will be at the current market rate.

What is a "due-on-sale" clause?

It is a provision found in all conventional mortgage contracts that upon sale of the property, the loan must be repaid. If it must be repaid, it cannot be assumed by the buyer.

Are there any exceptions?

Yes. Due-on-sale does not apply in many intrafamily transactions, such as a parent deeding a house to a child or a spouse, or following a death or a divorce. But the exceptions don't help home sellers in typical arms-length transactions.

Is there any way around due-on-sale clauses?

Quite a few, of which the most common is the wrap-around mortgage, executed without the permission or knowledge of the lender. With a wrap-around, the seller takes a mortgage from the buyer and continues to pay the old mortgage out of the proceeds of the new one. The new mortgage "wraps" the old one.

For example, S, who has a $140,000 mortgage on his home, sells his home to B for $200,000. B pays $10,000 down and borrows $190,000 on a new mortgage given by S. This mortgage "wraps around" the existing $140,000 mortgage because the seller, as the new lender, continues to make the payments on the old mortgage. Collectively, buyer and seller benefit by retaining the old low-rate mortgage. When interest rates start to rise significantly, we will see more wrap-around mortgages because the benefit from keeping old mortgages in play increases.

How is the benefit split between buyer and seller?

The buyer benefits by paying a mortgage rate below the current market rate, which will be only partly offset by the higher price paid for the house. The seller benefits from a higher price on his house, and/or from the spread between the rate paid by the buyer on the seller's mortgage and the rate the seller is paying on the old mortgage.

What is the down side?

The home seller who does this violates his contract with the lender, which he or she may not get away with. In some states, escrow companies are required by law to inform the lender when a loan is being wrapped. If a wrap-around deal on a nonassumable loan does close and the lender discovers it afterwards, the lender may call the loan or demand an immediate increase in interest rate and probably a healthy assumption fee.

If the seller has a new set of housing expenses and depends on the buyer's payment to him to fund the payment on the old mortgage, failure of the buyer to pay poses a major problem for the seller. The seller in such case must get the buyer evicted, using whatever legal processes are stipulated in the sale agreement and authorized by state law. In the meantime, the delinquencies will drop the seller's credit score.

The buyer is also at risk. If the seller for some reason does not make the payments on the old mortgage, the lender can foreclose and take the property. In that event, the buyer can retain the home only by making a deal with the lender, and has little bargaining power in the process.

Are there other, less risky ways a home seller and buyer can keep an existing low-rate mortgage alive?

Maybe. Lease-to-own transactions usually have other objectives, but since they do not involve paying off an existing mortgage, they can also be used for the primary purpose of keeping that mortgage alive.

Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at mtgprofessor.com.

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